HIGH COURT OF ANDHRA PRADESH
Chakra Financial Services Ltd.
versus
Commissioner of Income-tax
I.T.T.A. No. 10 of 2000
FEBRUARY 7, 2012
JUDGMENT
Sanjay Kumar, J.
The issue for consideration in this assessee’s appeal under section 260A of the Income-tax Act, 1961 (hereinafter, “the Act”) is as to the methodology of computation of the assessee’s income from finance charges.
2. The assessee is a public limited company engaged in the business of leasing, hire-purchase and finance. For the assessment year 1987-88, it admitted a loss of Rs. 7,09,738. The Assistant Commissioner of Income-tax, Central Circle-III, Hyderabad, however, assessed the income of the assessee at Rs. 6,77,460. This assessment was based on dis allowance of deductions and consequential additions in connection with finance charges, loss on revaluation of shares and notional interest on interest-free loans given by the assessee.
3. Finance charges represent the interest component of the hire-purchase monthly installments paid by hirers to the assessee. The assessee had itself credited Rs. 12,33,700 under this head in its profit and loss account. However, in its return of income the finance charges were reduced to Rs. 6,71,326 on the ground that the amount of Rs. 5,62,374 did not accrue as income though credited as such in the profit and loss account during the assessment year. The Assessing Officer (AO), however, did not accept this deduction and took into account the credited amount of Rs. 12,33,700 while computing the income under this head. The Assessing Officer also disallowed the deductions on the other two counts.
4. Dissatisfied with this assessment, the assessee filed an appeal before the Commissioner of Income-tax (Appeals) III, Andhra Pradesh, Hyderabad. By order dated November 30, 1990, the Commissioner accepted the stand of the assessee and allowed the appeal. Aggrieved, the Revenue carried the matter in appeal before the Income-tax Appellate Tribunal, Hyderabad Bench “A”, Hyderabad, in I.T.A. No. 463/Hyd/91. The two issues raised before the Tribunal related to the finance charges and the loss on revaluation of its shares. By order dated December 30, 1998, the Tribunal allowed the Revenue’s appeal and reversed the order passed by the Commissioner. Consequently, this appeal by the assessee.
5. Though the aspect of the alleged loss on revaluation of the shares held by the assessee was also sought to be raised, this court, while admitting the appeal, framed only one substantial question of law :
“We are of the view that the first question as to the methodology of computing the income representing receipts on account of finance charges and interest raises a substantial question of law to be decided in the appeal.
As regards the second question, i.e., loss claimed on account of re-valuation of shares, we do not find any arguable question of law and the reasoning given by the Tribunal is based on appreciation of facts.
The appeal is admitted as regards the first question indicated above.”
6. The scope of this appeal is, therefore, limited to the methodology of computation of the assessee’s income from finance charges earned through its hire-purchase and leasing operations.
7. It is not in dispute that the assessee credited Rs. 12,33,700 towards finance charges in its books of account. This figure was arrived at by adopting the “indexing” or “sum of digits” (SOD) system of accounting. However, while offering income under this head in its return of income, the assessee followed the mercantile system of accounting and reduced the income on this count to Rs. 6,71,326. The orders of the authorities below reflect that the hire-purchase agreements entered into by the assessee with its customers required finance charges to be paid at the rate of 15 per cent. per annum over a period of five years. The consolidated equated monthly instalment (EMI) payable by the hirers was detailed in schedule II of the agreement and each composite instalment of the EMI contained two elements-part principal and part finance charges. The “principal component” constituted capital receipt while the amount collected towards “finance charges” was obviously a revenue receipt. In its books of account, the assessee used the SOD system of accounting and reflected more receipts on the revenue account and less on the capital account from out of the EMIs received during the assessment year. While submitting its return of income, the assessee, however, adopted the mercantile system of accounting and showed lesser receipts on the revenue account.
8. To understand the difference in the two systems of accounting, it would suffice to extract the hypothetical example adopted by the Commissioner of Income-tax (Appeals) :
6. To illustrate the difference in accounting of incomes as per the indexing method and the mercantile system, a hypothetical transaction involving hiring of machinery worth Rs. 100 is taken, on which hire-purchase finance charges recoverable in five years is Rs. 70. The following are the amounts of recovery shown in the books of account and in the computation of income as per the return filed.
